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On
Friday, the IRS released proposed regulations under Sec. 3504
(acts to be performed by agents) that would govern the
liability for employment taxes when an employer designates an
agent under a “service agreement” to pay its employees and to
satisfy all employment tax obligations (REG-102966-10). Such agents include
payroll service providers, employee leasing companies, and
professional employer organizations.

The proposed
rules are intended to assist taxpayers and the IRS in
determining the parties’ employment tax obligations in a
three-party arrangement in which a payer has represented to
the employer that it will pay the employment taxes for wages
or compensation it pays to employees for services the
employees performed for the employer.

Generally,
employment tax liability is determined under the Code and
cannot be altered by an agreement between an employer and a
third party. In some limited circumstances, a third-party
payer may be considered the person responsible for withholding
and payment of employment taxes in addition to—or in lieu
of—the employer. Under Sec. 3504, if a third party pays wages
or compensation to employees who are employed by one or more
employers, the IRS can designate that payer to perform acts
required of employers under the Code.

Under the Sec.
3504 rules, agents use their own employer identification
number (EIN) when filing one aggregate Form 941, Employer’s
Quarterly Federal Tax Return, for all the employers for
whom they act (or one aggregate Form CT-1, Employer’s
Annual Railroad Retirement Tax Return, for all railroad
employers for whom they act). The payers file Form 941,
Schedule R, Allocation Schedule for Aggregate Form 941
Filers, to provide the breakdown for individual employers.
Employment taxes for these purposes include the employer and
employee portion of Federal Insurance Contributions Act (FICA)
taxes, Federal Unemployment Tax Act (FUTA) taxes, Railroad
Retirement Tax Act taxes (RRTA), and federal income taxes
withheld from wages.

Under existing rules, payers and
employers file Form 2678, Employer/Payer Appointment of
Agent, with each Form 941. A payer that undertakes these
obligations is liable for any tax or penalty that may apply,
but the employer also remains liable.

The proposed
regulations provide that, unless certain exceptions apply, a
payer can be designated as an agent under Sec. 3504 to perform
the acts required of an employer with respect to wages or
compensation paid by the payer to any individual performing
services for any client pursuant to a “service agreement”
between the payer and the client. In that case, the IRS states
that it will pursue recovery of unpaid taxes and penalties
only once—either from the payer or the employer.

A
service agreement is defined in the proposed rules as an
agreement between an employer and payer in which the payer
asserts it is the employer (or “co-employer”) of the
individuals performing services for the employer; pays wages
or compensation to the individuals; and assumes responsibility
to collect, report, and pay, or assumes liability for, any
employment taxes applicable for wages or compensation the
payer pays to the individuals performing services for the
employer (Prop. Regs. Sec. 31.3504-2(b)(2)).

The rules
under the proposed regulations would not apply if the wages
are reported on a return filed under the employer’s EIN, the
payer is a common paymaster under Secs. 3121(s) or 3231(i), or
the payer is the individuals’ employer (Prop. Regs. Sec.
31.3504-2(d)). Eight examples illustrate how these rules would
apply.

These rules will apply to wages or compensation a
payer pays under a service agreement in quarters beginning on
or after the date they are published as final in the
Federal Register. In the meantime, the IRS is
requesting comments, which must be received by April 29. In
particular, the IRS asks for comments on (1) whether the
definition of service agreement inappropriately results in a
payer’s being designated (or failing to be designated) an
agent under Sec. 3504; (2) whether additional exceptions are
warranted; and (3) whether additional examples should be
given.

With all the recent tax law changes, this year it’s more important than ever to make sure your clients’ tax situations are squared away before year end. This report provides necessary guidance to ensure 2019 starts without a hitch.

Don’t get lost in the fog of legislative changes, developing tax issues, and newly evolving tax planning strategies. Tax Section membership will help you stay up to date and make your practice more efficient.